We have been patiently waiting for markets to correct and give us a chance to purchase positions that edge our portfolios closer to a neutral stance. But so far this year, the volatility tap has been shut as we continue to watch a slow drift up in the markets. This has tested our patience as we wait for a catalyst to erupt and take some of the froth out of the market.
As always, a catalyst could come from any arena. Today has brought weak Chinese export data, S&P downgrades of Italian banks, riots breaking out in Greece, and a measure of U.S. confidence coming in lower than expectations. All of these could potentially fit the bill. Maybe more likely is that the catalyst will ultimately come in the form of something no one is thinking about (like last year’s Tsunami in Japan). We would welcome any catalyst at this point, as we’d rather buy when things go on sale rather than when they seem to be getting a little pricey.
There is one scenario that’s been gnawing at me — the possibility that the volatility tap may not open up in the short term, despite complacent sentiment and poor seasonality. The reason for this would simply be that many money managers are likely light on risk exposure and looking to add exposure on a dip, just like us. Given that the market enjoys making a mockery out of most investors, maybe this frustrating environment continues until the weak hands throw in the towel in a wave of buying. If that scenario occurs, then stretched markets could simply get more stretched before things break. Because of our decision to migrate portfolios back to the neutral zone, volatility has become an ally that would allow us to buy cheaper and with less froth. Therefore we’re hoping the volatility tap is ready to open up and flow through the markets again.